Internal Revenue Bulletin:
2008-11

March 17, 2008

Rev. Rul. 2008-16

S corporations; charitable contributions. This ruling provides guidance for S corporations that made charitable
contributions of appreciated property during a taxable year beginning
after December 31, 2005 and before January 1, 2008. The ruling provides
that the amount of the charitable deduction the shareholder may claim
may not exceed the sum of (i) the shareholder’s pro
rata share of the fair market value of the contributed
property over the shareholder’s pro rata share of the contributed property’s adjusted tax basis, and
(ii) the amount of the Code section 1366(d) loss limitation amount
that is allocable to the contributed property’s basis under
regulations section 1.1366-2(a)(4).

ISSUE

If an S corporation makes a charitable contribution of appreciated
property in a taxable year beginning after December 31, 2005, and
before January 1, 2008, what is the amount of the charitable contribution
deduction that a shareholder may claim in circumstances where § 1366(d)
of the Internal Revenue Code (Code) limits the shareholder’s pro rata share of the S corporation’s losses and
deductions for the taxable year in which the property is contributed?

FACTS

Individual A is the sole shareholder of
S Corporation X. At the beginning of X’s 2007 taxable year, A has
a basis of $50x in the X stock. During 2007, X makes a charitable contribution of unencumbered real
property, with an adjusted basis of $100x and a fair market value
of $190x, in a transaction that qualifies under § 170(c).
The charitable contribution is not subject to the limitations of
§ 170(e)(1). In 2007, X has §1363
taxable income of $30x and a long-term capital loss of $25x.

LAW

Section 170(a) allows as a deduction any charitable contribution
(as defined in § 170(c)) the payment of which is made during
the taxable year. The deduction allowable by § 170(a) is
subject to the limitations of § 170(b).

Section 1.170A-1(c)(1) of the Income Tax Regulations provides
that if a charitable contribution is made in property other than money,
the amount of the contribution is the fair market value of the property
at the time of the contribution reduced as provided in § 170(e)(1)
and § 1.170A-4(a), or § 170(e)(3) and § 1.170A-4A(c).

Section 1363(b)(2) provides that the taxable income of an S
corporation shall be computed in the same manner as in the case of
an individual, except that the deductions referred to in § 703(a)(2),
including the deduction for charitable contributions provided in § 170,
shall not be allowed to the corporation.

Section 1366(a)(1)(A) provides that, in determining the tax
of a shareholder, there shall be taken into account the shareholder’s pro rata share of the corporation’s items of income,
loss, deduction, or credit the separate treatment of which could affect
the liability for tax of any shareholder. Section 1366(a)(1) provides
further that the items referred to in § 1366(a)(1)(A) include
amounts described in § 702(a)(4). Section 702(a)(4) refers
to charitable contributions (as defined in § 170(c)).

Section 1366(a)(1)(B) provides that, in determining the tax
of a shareholder, there shall be taken into account the shareholder’s pro rata share of any nonseparately computed income or
loss.

Section 1366(d)(1) provides that the aggregate amount of losses
and deductions taken into account by a shareholder under § 1366(a)
for any taxable year shall not exceed the sum of (A) the adjusted
basis of the shareholder’s stock in the S corporation, and
(B) the shareholder’s adjusted basis of any indebtedness of
the S corporation to the shareholder.

Section 1366(d)(2)(A) generally provides that any loss or deduction
which is disallowed for any taxable year by reason of § 1366(d)(1)
shall be treated as incurred by the corporation in the succeeding
taxable year with respect to that shareholder.

Section 1.1366-1(a)(2)(i) and (iii) provides that each S corporation
shareholder must take into account separately the shareholder’s pro rata share of the S corporation’s gains and
losses from sales or exchanges of capital assets and the corporation’s
charitable contributions.

Section 1.1366-1(a)(3) provides that each shareholder must take
into account separately the shareholder’s pro rata share of the nonseparately computed income or loss of the S corporation.

Section 1.1366-1(b)(1) provides, in part, that the character
of any item of income, loss, deduction, or credit described in § 1366(a)(1)(A)
or (B) is determined for the S corporation and retains that character
in the hands of the shareholder.

Section 1.1366-2(a)(4) generally provides that if a shareholder’s pro rata share of the aggregate amount of losses and deductions
exceeds the sum of the adjusted basis of the shareholder’s stock
in the corporation and the adjusted basis of any indebtedness of the
corporation to the shareholder, then the limitation on losses and
deductions under § 1366(d)(1) must be allocated among the
shareholder’s pro rata share of each loss
or deduction. The amount of the limitation allocated to any loss
or deduction is an amount that bears the same ratio to the amount
of the limitation as the loss or deduction bears to the total of the
losses and deductions.

Section 1367(a)(1)(B) provides that the basis of each shareholder’s
stock in an S corporation is increased for any period by any nonseparately
computed income determined under § 1366(a)(1)(B).

Section 1367(a)(2)(B) provides that the basis of each shareholder’s
stock in an S corporation is decreased for any period (but not below
zero) by the items of loss and deduction described in § 1366(a)(1)(A).

Section 1.1367-1(f) provides that increases in an S corporation
shareholder’s stock basis that are attributable to income items
described in § 1367(a)(1)(B) are made before decreases in
such basis that are attributable to items of loss or deduction described
in § 1367(a)(2)(B).

Section 1203(a) of the Pension Protection Act of 2006 (Pension
Act), P.L. 109-280, 120 Stat. 780 (2006), amended Code § 1367(a)(2)
to provide that the decrease in shareholder basis under § 1367(a)(2)(B)
by reason of a charitable contribution (as defined in § 170(c))
of property shall be the amount equal to the shareholder’s pro rata share of the adjusted basis of such property.
The Technical Explanation of the Pension Act, Technical Explanation
of H.R. 4, “The Pension Protection Act of 2006,” JCX-38-06
page 271, provides the following illustration of § 1203:

Thus, for example, assume an S corporation with one individual
shareholder makes a charitable contribution of stock with a basis
of $200 and a fair market value of $500. The shareholder will be
treated as having made a $500 charitable contribution (or a lesser
amount if the special rules of section 170(e) apply), and will reduce
the basis of the S corporation stock by $200. (Footnote 306: This example assumes that basis of the S corporation stock
(before reduction) is at least $200.)

Section 3(b) of the Tax Technical Corrections Act of 2007 (Technical
Corrections Act), P.L. 172, 121 Stat. 2473 (2007), added § 1366(d)(4),
which concerns the application of the basis limitation rule of § 1366(d)(1)
to charitable contributions of appreciated property by S corporations.
Generally, under § 1366(d)(1), the amount of losses and
deductions which a shareholder of an S corporation may take into account
in any taxable year is limited to the shareholder’s adjusted
basis in his stock and indebtedness of the corporation. Section 1366(d)(4)
provides that, in the case of a charitable contribution of property,
§ 1366(d)(1) shall not apply to the extent of the excess
(if any) of (A) the shareholder’s pro rata share of such contribution, over (B) the shareholder’s pro rata share of the adjusted basis of such property.
Thus, the basis limitation rule of § 1366(d)(1) does not
apply to the amount of deductible appreciation in the contributed
property. See Description of the Tax Technical
Corrections Act of 2007, JCX-119-07, pages 2-3.

The Pension Act amendment to § 1367(a)(2) and the
Technical Corrections Act amendment to § 1366(d) apply to
charitable contributions made by S corporations in taxable years beginning
after December 31, 2005, and before January 1, 2008. Charitable contributions
made by S corporations in taxable years beginning after December 31,
2007, barring any statutory change, are subject to the law in existence
prior to these amendments. The IRS and Treasury Department are considering
issuing guidance on the treatment of charitable contributions made
by S corporations in taxable years beginning after December 31, 2007.

ANALYSIS

Under the facts of this revenue ruling, X makes a charitable contribution of unencumbered real property with
an adjusted basis of $100x and a fair market value of $190x in a transaction
that qualifies under § 170(c). The charitable contribution
is treated as a separately stated item of deduction that passes through
to A and is deductible in computing A’s individual tax liability. Section 1.1366-1(a)(2)(iii).

Pursuant to § 1.1367-1(f), A’s
$50x basis in the X stock is first increased
by $30x under § 1367(a)(1)(B) to reflect A’s share of X’s taxable income.
A’s basis in the X stock is then decreased (but not below zero) by A’s pro rata share of the sum of the adjusted
basis of the contributed property ($100x) pursuant to the flush language
of § 1367(a)(2) and by A’s pro rata share of X’s long-term
capital loss ($25x) pursuant to § 1367(a)(2)(B). However, A’s pro rata share of the aggregate
amount of losses and deductions ($125x) exceeds A’s basis in the X stock of $80x. Section
1366(d)(1), accordingly, will limit the allowable losses and deductions
to A for X’s 2007
tax year.

Pursuant to § 1366(d)(4), the basis limitation rule
in § 1366(d)(1) does not apply to a contribution of appreciated
property to the extent the shareholder’s pro rata share of the contribution exceeds the shareholder’s pro rata share of the adjusted basis of the contributed
property. Accordingly, the basis limitation rule of § 1366(d)(1)
does not apply to A’s pro rata share of
the amount of deductible appreciation in the contributed property
($90x).

Under § 1.1366-2(a)(4), when a shareholder has losses
or deductions in excess of the sum of the shareholder’s basis
in the stock plus indebtedness of the S corporation to the shareholder,
the limitation on losses must be allocated pro rata to each item of loss or deduction. In the case of a charitable
contribution deduction, the limitation amount allocable to such deduction
is determined by reference to the shareholder’s pro
rata share of the contributed property’s adjusted
basis pursuant to § 1366(d)(4).

In applying § 1.1366-2(a)(4), the amount of the limitation
allocable to a charitable contribution deduction is an amount that
bears the same ratio to the § 1366(d) limitation as the
shareholder’s pro rata share of the contributed
property’s adjusted basis bears to the total of the shareholder’s pro rata share of the corporation’s losses and deductions
(excluding the charitable contribution deduction attributable to the
shareholder’s pro rata share of the fair
market value of the contributed property over the contributed property’s
tax basis). Accordingly, the amount of the limitation allocable to A’s share of X’s charitable
contribution deduction is determined by multiplying A’s basis in the X stock ($80x) by a fraction,
the numerator of which is $100x (the contributed property’s
adjusted basis) and the denominator of which is $125x (the total of
the capital loss and the contributed property’s adjusted basis).
Thus, $64x is allocated to the charitable contribution deduction.
The remaining $16x is allocated to the capital loss.

Accordingly, in 2007, the amount of the charitable contribution
deduction that A may claim is $154x. This amount
is comprised of A’s pro rata share of the property’s appreciation ($90x) plus the amount
of the loss limitation allocated to A’s pro rata share of the contributed property’s adjusted
basis ($64x). Under § 1367(a)(2)(B), A’s basis in the X stock is reduced to
0 to reflect the $16x reduction in basis attributable to the capital
loss and the $64x reduction in basis attributable to the charitable
contribution deduction. Pursuant to § 1366(d)(2), the disallowed
portion of the charitable contribution deduction ($36x) and the capital
loss ($9x) shall be treated as incurred by X in
the succeeding taxable year with respect to A.

HOLDING

If an S corporation makes a charitable contribution of appreciated
property during a taxable year beginning after December 31, 2005,
and before January 1, 2008, the amount of the charitable contribution
deduction the shareholder may claim may not exceed the sum of (i)
the shareholder’s pro rata share of the
fair market value of the contributed property over the contributed
property’s adjusted tax basis, and (ii) the amount of the § 1366(d)
loss limitation amount that is allocable to the contributed property’s
adjusted basis under § 1.1366-2(a)(4). Any disallowed portion
of the charitable contribution retains its character and is treated
as incurred by the corporation in the corporation’s first succeeding
taxable year, and subsequent taxable years, with respect to the shareholder.

DRAFTING INFORMATION

The principal author of this revenue ruling is Cynthia D. Morton
of the Office of Associate Chief Counsel (Passthroughs & Special
Industries). For further information regarding this revenue ruling,
contact Cynthia D. Morton at (202) 622-3060 (not a toll-free call).